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Monday, June 6, 2016

06/06/1966 was a devilish day for the Indian Rupee...Why?

The 6th of June is a noteworthy date in India’s currency calendar.
Fifty years ago, on 6 June 1966, the rupee was devalued dramatically in
response to the first significant balance of payments crisis faced by
independent India.

It had barely been a decade-and-a-half since India had achieved
independence. The economy, still finding its feet, had limited access to
foreign exchange. Foreign investments were frowned upon and exports
were negligent. The 1950s and the early 1960s were, therefore, years
when India ran up high trade deficits. Foreign aid from rich nations was
what came to India’s rescue.

Things got tough in 1965 as India
and Pakistan went to war. Military spending skyrocketed, putting further
pressure on the Indian government’s finances. At the same time,
countries like the US, which were in those days aligned with Pakistan,
withdrew aid from India.

With limited options, the Indira
Gandhi-led government that followed in 1966 resorted to a steep
devaluation of the rupee, in a decision that was widely criticized.

The
rupee in those days was still pegged to the pound, which, in turn, was
pegged to the dollar. The devaluation meant that the effective value of
the rupee went from Rs.4.76 against the dollar to Rs.7.50 per dollar. That worked out to be a devaluation of 57%.

The
Reserve Bank of India (RBI) documents 1966 as the second episode of
rupee devaluation, the first being a consequence of a devaluation in the
pound, to which the rupee was pegged.

“Consequent to the
devaluation of pound sterling, rupee was automatically devalued to the
same extent (as the pound sterling) on 18 September 1949. Rupee was
again devalued on 6 June 1966 to correct the external payments which had
reached a state of critical disequilibrium,” says an RBI document.

“The
measure was also resorted to with a view to maintain the existing
exports by bringing about a better alignment between internal and
external prices and, thus, giving exports greater competitive strength.
Corresponding new rate of exchange was Rs.7.50 to 1 US dollar as against the previous rate of Rs.4.76,” adds RBI.

A.V.
Rajwade, a veteran risk and foreign exchange consultant, columnist and
author, recalls the decision to devalue the rupee in 1966 as the first
of “many unpopular decisions” taken by the government led by Gandhi.
“There was a bias against foreign investment at the time which means the
country was dependent on foreign aid,” said Rajwade. “The devaluation
didn’t work. It led to a spike in inflation and did little to help in
the long term as it was not accompanied by any other reforms,” added
Rajwade,

According
to a 2002 paper, authored by Devika Johri and Mark Miller and published
by the Centre for Civil Society, inflation levels went up from about
5.8% in the 1961-65 period to about 6.7% in 1966-70.
The data
compiled by Johri and Miller shows the trade deficit did fall in the
aftermath of the devaluation, although it would be tough to argue there
was a sustainable improvement in India’s external economy, which went on
to face another major balance of payments crisis in 1991. The data
shows the trade deficit narrowed from a peak of Rs.930 crore in 1965 to Rs.100 crore in 1970, led more by a contraction in imports than a rise in exports.

Jamal
Mecklai, another veteran of the foreign exchange markets, recalls he
was in his teens at the time and says: “It was another planet” at that
time.

“It is a date in history, but it is meaningless to compare
what we were then and what we are now. In those days, transactions were
in pound sterling and the market lot size was maybe £15,000. There were
hardly any transaction and you had a good day if there were 10-12
transactions,” said Mecklai,

“1991 was obviously far more significant,” he added.
Indeed,
it was in 1991 and the years that followed that the real turning point
for the Indian economy and the rupee was reached.

“1991-92
represents a major break in policy when India harped on reform measures
following the balance of payments crisis and shifted to a
market-determined exchange rate system,” says an RBI document, which
details the development of the foreign exchange markets.

“India
has been operating on a managed floating exchange rate regime from March
1993, marking the start of an era of a market-determined exchange rate
regime of the rupee, with provision for timely intervention by the
central bank. India’s exchange rate policy has evolved over time in line
with the global situation and as a consequence to domestic
developments,” says RBI.

These numbers help tell the story of how far India has come since 6 June 1966:
*
The rupee, which was then pegged down to 7.50 against the dollar now
trades at near 67 in an exchange rate system that is market driven.
* India’s current account deficit in fiscal 2016 is seen at a modest 1.5%.
* India’s foreign exchange reserves of more than $360 billion are enough to cover more than nine months of imports.
* India was the top destination for foreign direct investment flows in 2015.
~
Source : livemint

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